A “long-yearned-for shock of liberation” for taxpayers.

Hypo Alpe-Adria bank, when it was still owned by the small Austrian state of Carinthia, was a cesspool of corruption. It involved bankers, politicians, and powerbrokers in Austria and the Balkans. It was the perfect union of money and power. Investigators found 160 instances of suspected fraud, amounting to €1.6 billion, of which €890 million occurred in Austria, €250 million in Croatia, €164 million in Bosnia and Herzegovina, among others. Six of the bank’s former executives have been convicted of crimes.

“I’m not aware of a criminal case bigger than this one,” explained Christian Böhler, whose forensics team started investigating the bank in 2011. “It was a mix of greed, criminal energy, and utter chaos.”

The sheen started to come off in 2006. The Austrian banking supervisor determined that executives had buried over €300 million in losses. And Hypo’s business model fell apart: it had been issuing bonds guaranteed by Carinthia that gave it access to cheap money to fund it shady activities. But the EU prohibition against state guarantees was kicking in. So it was time for Carinthia to sell the bank.

Sure enough, in 2007, state-owned Bavarian bank, BayernLB, despite warnings from its own analysts – a “squeezed-out lemon,” they called Hypo – bought a majority stake for €1.66 billion. Within months, BayernLB had to bail out its crown jewel with a capital injection of €441.3 million.

In 2008, BayernLB itself toppled and was bailed out by the German and Bavarian taxpayers to the tune of €10 billion, of which €700 million went to prop up Hypo, along with €900 million from the Austrian government. In 2009, Bavaria shuffled its Hypo jewel off to Austria, which nationalized it. The deal left Bavaria as one of Hypo’s creditors. It has since sued Austria, which has countersued, and more suits and countersuits followed.

Other notable Hypo bondholders include the World Bank and Aurelius Capital Management, which was one of the hedge funds that chased Argentina all the way to the US Supreme Court.

A year ago, Austria’s central bank governor Ewald Nowotny and his task force recommended that Hypo’s toxic assets of €17.8 billion should be put into a “bad bank.” But to stop the drag on public finances, the federal government should not guarantee Hypo’s bonds. At the time, Austrian taxpayers had already plowed €4.8 billion into Hypo to bail out these bondholders.

He then explained on TV to incredulous Austrians that this deal would nudge the budget deficit over the 3% limit set by the Maastricht Treaty and push the government’s debt from 74.4% of GDP to 80% of GDP. This one rotten, state-owned bank in Carinthia was causing this much damage to the country’s finances!

Nowotny exhorted the government to not let Hypo become insolvent because the €12.5 billion in guarantees that Carinthia had issued would then push the state itself into bankruptcy.

But to the consternation of bank bondholders around the world, Finance Minister Michael Spindelegger dug in his heals and refused to rule out letting Hypo become insolvent; bondholders, instead of taxpayers, would then get to eat the losses.

Now the moment has come. Another audit discovered a new financial hole of €7.6 billion. And that was it.

On March 1, the exasperated Financial Markets Authority (FMA) announced a moratorium of debt payments by the renamed Heta Asset Resolution AG, under the “new European regime of winding down banks” that calls for bondholders to take a hit and for taxpayers to be largely spared.

In order to formulate this wind-down plan that “conforms to the goals of the new regimes,” the bad bank would make neither principal nor interest payments on the affected debts, which include the bonds guaranteed by Carinthia, senior bonds that had been spared so far, and some unquantified debt to BayernLB. Effective till May 31, 2016, the debt moratorium was designed to spare Austria’s taxpayers additional costs beyond the €5.6 billion they’d forked over so far. The FMA added later that even bankruptcy was not excluded.

“The government won’t pay another euro in taxpayer money into Heta,” Schelling told his ORF radio audience on Monday. Bondholders would take steep losses, even on bonds guaranteed by Carinthia. It would be up to Carinthia to bail them out, but Carinthia with its 560,000 souls, wouldn’t be big enough to do so. “Everyone who bought a bond should have known that there is a risk to any bond, no matter where you buy it,” he said.

On cue, those bonds plunged, trading for less than half their face value. Capital markets work if you let them.

And what if Heta becomes insolvent?

It’s likely “that Carinthia will go bankrupt,” constitutional lawyer and former Dean of the Faculty of Vienna, Heinz Mayer, told the German paper FAZ, echoing what Nowotny had warned about a year ago. But unlike Nowotny, he considered it “manageable.”

Heta’s bankruptcy, despite what it means for Carinthia, “would be the only way to finally relieve the taxpayer who has already paid billions,” he said; Heta was a “bottomless pit that could consume up to €20 billion,” or about 6% of Austria’s economic output.

A “long-yearned-for shock of liberation” for taxpayers, that’s what Franz Schellhorn, director of economics think tank Agenda Austria, called Schelling’s announcement that the “federal government won’t save irresponsibly acting states at all costs.”

“That would mean that Carinthia slithers into bankruptcy in one year,” he said. Otherwise, given the ever expanding extent of the debacle, “whole generations” would probably have to pay for it. “And the good thing is that the government, to protect the taxpayers, finally pulled the ripcord.”

Throughout the Financial Crisis, and since, there has been one rule: bank bondholders will always be bailed out at the expense of everyone else. The sanctity of bank bonds reigned supreme, no matter what government and central banks had to do to keep it that way. Bank bonds weren’t allowed to be judged by the capital markets. They were simply untouchable. Underpaid and overtaxed workers would have to bail out bank bondholders when these recklessly managed banks collapsed.

That was the rule in the US when the Fed, and to a lesser extent the federal government, bailed out the banks. And that was the rule during the debt crisis in Europe.

But cracks appeared more recently. When SNS Reaal, fourth largest bank in the Netherlands, re-collapsed and was nationalized in early 2013, stockholders got wiped out, as were holders of junior bonds. That was new. It sent tremors through the system. It was the needle that pricked the Eurozone bailout bubble.

But holders of senior bonds were made whole. The bailout cost Dutch taxpayers €3.7 billion. The sanctity of senior bank bonds and their implicit taxpayer guarantees were maintained.

Austria now changed that. Banks would be allowed to go bankrupt. Even senior bondholders would get to eat the losses. And even states that had guaranteed these bonds would be allowed to go bankrupt to protect their taxpayers. A monumental change! What a novel idea to let bank bondholders relearn the notion of risk, and price it in.

This is only the beginning. The Heta disaster will unravel the entire Austrian banking sector. First Pfandbriefstelle (renamed Pfandbriefbank), then all the 8 Landeshypos, then Raiffeisen (they own 3 of the Landeshypos).

NOTaREALmerican

Mar 4, 2015 at 1:44 pm

Wow, sure takes a lot of corruption, and for a long time, for the government to stop bailing out a bank. Good think I work for a TBTF US bank. I should have a few life-times left before anything like that happens here.

HSBC is the king of the hill. It’s coddled by the UK government, and governments around the world. Its executives are beyond criminal investigations, unlike those of Hypo. And all this is the topic of a number of posts on WS. Hypo was small, compared to HSBC, but it was taken down, stockholders (unfortunately the public) got wiped out, bondholders are going to pay, executives have criminal convictions…. And maybe the lesson is allowed spread from there to larger banks.

SteveK9

Mar 5, 2015 at 7:49 am

After the S&L crisis ~ 1000 bankers were convicted of crimes. A lot of them by William Black, who writes often about what we could/should have done after the financial crisis. I’ve pretty much given up hope. Bank executives have too much political power.

A different President could have used the panic in 2009 to temporarily take over the banks, recapitalize them, put new management in place, and throw the previous crooks in jail. That is exactly what should happen under those circumstances. And, is the fastest way to correct the problem. President Obama was simply not experienced enough, bold enough, … whatever, to take those actions. Unfortunately he was no FDR.

It didn’t happen then and it is too late for it to happen now. It may be that there will be another crisis and people will finally demand that we reform the financial sector and break its hold on our political system and economy. We need Banking to be boring again.

HSBC is really something … laundering money for criminals and murderers is just one illegal activity. Do you know that HSBC was founded in the aftermath of the Opium Wars in 1865 and has been involved in the drug trade since the beginning? Here is a small quote from Dean Henderson:

Formerly known as Hong Kong Shanghai Bank Corporation, HSBC has served as the world’s #1 drug money laundry since its inception as a repository for British Crown opium proceeds accrued during the Chinese Opium Wars. During the Vietnam War HSBC laundered CIA heroin proceeds.

Appears to be a land of wind-swept peaks and forbidding castles. Perhaps they’ll burn a banker at the stakes and provide a good example for the rest of us.

MC

Mar 5, 2015 at 9:44 am

I’d like to chip in a few nuggets from the ground.

Carinthia has long been hailed as a “success story”: it managed to attract sizable foreign investments from other EU countries due to extremely favorable conditions. Tax breaks for firms for the first five years in operation, hefty rebates on energy, lower commodity costs (lumber, natural gas etc)… you name it. The local government marketed itself very aggressively chiefly to German and Italian firms, but they got people to open shop there from as far afield as Great Britain.

I had the occasion of speaking with the owner of a firm who opened a manufacturing facility in Carinthia. Mind this was five years ago. He told me “Not everything that glitters is gold”. When pressed, he told me Austria’s greatest economic woe was their banking sector “Overleveraged, mired in shady deals and far too politicized”. He singled out Hypo-Alpe-Adria as the worst culprit, followed by Raiffeisen. Looks like he was correct and I wonder if he has since closed that manufacturing facility, given the tax breaks by now must have run their course.
Those firms who opened shop in Carinthia or even moved there are going to get slaughtered.

If the taxpayers cannot- or will not bail out bank bondholder/creditors then depositors will. The alternative is for tycoons to repay their own gargantuan debts. That will never happen because a) the tycoons do not have the money only ‘assets’ and b) they would not be tycoons if they repay.

Let the bail-ins/bank runs commence.

KENGURU

Mar 6, 2015 at 2:12 pm

I would only argue one point here. “a) the tycoons do not have the money only ‘assets’”. If these are tangible assets they should be seized by the law enforcement and auctioned out to pay the debt. But that is not going to happen, because the law enforcement agencies are busy chasing 7/11 shop lifters.

kenguru

Mar 6, 2015 at 2:20 pm

If anybody here thinks that this is just a case of corruption you have to have your head examined. This is an organized scheme of transferring wealth from “taxpayers” and “savers to a club of gangsters. The end result should be as this:
-you have no money, not in pensions, not in savings, not in funds
-local and federal governments should be all in debt to give up infrastructure and governance to this club of gangsters
-the club of gangsters will own everything, including your lives.

If you cannot see, God help you open the eyes.

Petunia

Mar 6, 2015 at 3:04 pm

You are so right. The other thing I would add is that young people really understand this and they will not be fooled into participating in the coming “crisis” management options. The military seems to be getting pretty disgusted with all the resource wars too. It looks like the multinationals and bankers will need big bucks to buy an army to save them, good luck.